New OECD framework and its impact for India and the world
Taxation of the digital economy has been a sensitive topic and under the umbrella of the Inclusive Framework on BEPS, the OECD has done a lot of work to try to reach consensus on how to tax digital businesses. After years of deliberation and negotiation, a breakthrough occurred on July 1, 2021, when 131 of the 139 Members of the Inclusive Framework, representing over 90% of global GDP, agreed to the global minimum tax proposal. This consensus is a historic development to meet the challenges of digitalization in market jurisdictions from a tax perspective. The deal is expected to translate into additional annual tax revenue of around $ 150 billion, with most of it going to market jurisdictions.
This proposal operates on two pillars of which pillar 1 deals with the more equitable allocation of profits to market jurisdictions regardless of the physical presence of the entities there for which a multilateral convention can be implemented from 2023 while the pillar 2 introduced an overall minimum tax of 15 percent. The main characteristics of pillars 1 and 2 are as follows:
Pillar 1 would apply to MNEs meeting the criteria of a worldwide turnover above 20 billion euros and a profitability of 10% (ie PBT / income). The turnover threshold will eventually be reduced to 10 billion euros. Revenues from extractive industries and regulated financial services will remain excluded. 25% of residual profits, i.e. profits greater than 10% of revenues, will be allocated to market jurisdictions with certain links. This is called the A amount.
Nexus will be said to be established when the multinational will derive at least 1 million euros in revenue from this jurisdiction. For smaller jurisdictions with a GDP of less than 40 billion euros, the link will be set at 250,000 euros.
Work on the B-pillar, i.e. streamlining the arm’s length principle with core marketing and distribution activities in the country, will be completed by the end of 2022.
Members agreed not to levy any other similar tax on digital services from October 8, 2021 until December 31, 2023, as it is expected that by then, the multilateral convention incorporating the proposals will come into effect.
Pillar 1 will enter into force through the multilateral convention which will be drawn up and signed in 2022, with amount A taking effect from 2023. The MLC will contain the necessary rules to determine and allocate amount A and eliminate double taxation, as well as the process of simplified administration, information exchange and the prevention and resolution of disputes.
Pillar 2 is a mixture of several rules such as the income inclusion rules (IIR, i.e. the tax on the parent entity for the low taxed income of one of its constituents), the under-taxed payment rule (UTPR, i.e. the refusal of deduction insofar as the low-taxed grantor is not subject to under the IIR) and subject to the tax rule (STTR , i.e. the source country tax on certain related party payments subject to tax below a minimum rate). There would be a 10-year transition period for a certain exclusion of a certain percentage of income, the exclusion is reduced from year to year. Certain other exclusion thresholds for certain MNEs are also prescribed.
In addition, the provision of the Model Convention on the tax rule is to be developed by November 2021. Pillar 2 will enter into force in 2022, to enter into force in 2023, with the UTPR entering into force in 2024.
Several countries, including India, had proposed some sort of unilateral measure to tax the digital economy as an interim solution. In fact, the Equivalization Levy of India was the subject of an American investigation under Section 301 of the US Trade Act, 1974. This was considered discriminatory and contrary to international principles by the States- United. The United States, however, maintained retaliatory tariffs as this deal was imminent.
India, being a big market for big tech companies, has always endorsed the global tax deal and had to join this inclusive OECD / G20 framework.
Consensus on profit distribution was an important part of the deal. Once this consensus is reached, the equalization tax, which was imposed as a unilateral measure by India on digital transactions, will be canceled once the multilateral convention enters into force. Significant Economic Presence (SEP) provisions could also meet the same fate.
This is a welcome step aimed at tax security and in line with the upgrading of international tax systems to be adapted to the tax challenges of today’s digital world. EL’s Indian revenue currently stands at approximately Rs 1,618 crore for the current fiscal year. The agreed revenues are expected to exceed the agreed measures and bring certainty to the taxation of the digital economy globally.
The author, Amit Maheshwari is a partner at AKM Global. Also assisted by Sandeep Sehgal and Yeeshu Sehgal. Opinions expressed are personal
First publication: STI